13. Chapter 8: the investor and market fluctuations
Different ranges of fluctuations for different types of investment:
. very small fluctuations – short maturity (< 7 years) high-grade bonds; savings bonds
. larger fluctuations – longer-term bonds
. largest fluctuations – shares
13.1 Market fluctuations as a guide to investment decisions
The intelligent investor can profit from fluctuations by way of timing and by way of pricing.
Timing is psychologically important for the speculator because he is only thinking short-term, he is in a hurry to take his profit, he hates the idea that he might have to wait a year or more for his shares to move up.
The intelligent investor should forget about timing, forget about market forecasts, and concentrate on pricing:
“Basic pricing” means “not paying too much for shares“.
This essential minimum of attention is probably enough for the defensive investor.
“More ambitious pricing” means “buying below fair price and selling above fair price”.
The speculator is always in a hurry, but the investor can wait. Timing is of no advantage to the investor unless it coincides with pricing. If you keep a large amount of cash in hand, waiting for the “right time to buy”, when prices are “low enough”, then you lose dividend income.
The only advantage of waiting with a large amount of cash is if you can buy later at a low enough price to make up for loss in dividend income.
13.2 “Buy low, sell high” approach
Forget about trying to forecast price movements.
While “buy low, sell high” is clearly a sound idea, it’s hard to know when the market has bottomed-out (for buying) and when it has reached its peak (for selling). Hence the policy of changing the proportion of shares to bonds to re-balance the portfolio, if desired, in response to market fluctuations. (This policy is called “tactical asset allocation”, see also Chap. 4, pp. 89-91).
13.3 “Formula invesment” plans
Dollar-cost averaging is the only important one.
13.4 Market fluctuations of the investor’s portfolio
“The investor may as well resign himself in advance to the probability, rather than the mere possibility, that most of his holdings will advance 50% or more from their low point and decline 33% or more from their high point at various periods in the next five years”.
The main advantage of the policy of varying the proportion of stocks to bonds is that it gives the investor something to do and it gives him the satisfaction that his actions are opposite to the actions of the masses of investors who buy when prices rise. (See “rebalancing”, p. 104-105).
13.5 Business valuations versus market fluctuations
A shareholder has a two-fold status:
a. as part-owner of (and “silent partner” in) a private business, his results are entirely dependent on the profits of the enterprise and changes in its assets, he can calculate his share of the net worth from the latest balance sheet.
b. he is the holder of a share certificate which can be sold quickly. The selling price can be quite far removed from the balance-sheet value.
The development of the stock market has made the typical investor less free to consider himself as the part-owner of a business.
This is because he has to pay a “market premium” for the successful enterprises in which he is likely to concentrate his holdings, i.e. such enterprises sell at prices well above their book value.
(Zweig: book value, net asset value, balance sheet value and tangible asset value are synonyms for net worth.)
Book value is the total value of a company’s physical and financial assets minus all liabilities.
You can calculate “book value per share” (BVPS) from the balance sheet in a company’s annual and quarterly reports, using the following formula:
BVPS = (total shareholders’ equity – soft assets*) / (fully diluted no. of shares)
(*) soft assets = goodwill, trademarks and other intangibles
There is a built-in contradiction in the structure of stock-market prices: the better the company’s record and prospects, the less relationship there is between the price of shares and the book value of the company (Lyle’s note: and so the higher the premium), but the higher the premium, the more this “value” depends on the changing moods of the stock market.
Final paradox: the more successful the company, the greater the fluctuations are likely to be and hence the higher the quality of the company, the more speculative it is likely to be, e.g. IBM and Xerox have had striking losses at times, not because of any doubts about the companies themselves but because of a lack of confidence in the market about the valuation of the market premium.
The premium can be considered as a sort of extra fee which is paid for the advantages of marketability which are achieved by being listed on the stock market. The defensive investor might be better to confine himself to companies with premiums less than 33%,
... but a word of warning - this alone is not enough to indicate a sound investment, which has: a low premium, a satisfactory p/e, a strong financial position and good prospects that earnings will continue into the future.
13.6 “Mr Market”
Graham says that it can be useful to imagine that the market is a person called “Mr Market” who comes to you every day and makes suggestions about your portfolio (sell, buy, hold).
The true investor can choose to accept or refuse Mr Market’s suggestions, this is the investor’s basic advantage.
Mr Market’s suggestions are only important in the practical sense that they give an indication that levels might be attractive for buying or selling.
13.7 Summary
“The most realistic distinction between the investor and the speculator is in their attitude to stock market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in finding (and holding) suitable investments at suitable prices.”
Holding off until low prices appear before buying may sometimes involve a very long wait, and hence a loss of dividend income over the waiting period.
If you suddenly have money to invest, bargains can be found at any time if you know how to look for them.
The investor with a portfolio should expect price fluctuations, even large fluctuations.
He should never buy a share because it has gone up or sell one because it has gone down. More simply, never buy shares immediately after a substantial rise or sell after a substantial drop.
The management of companies can not be held accountable for overall market fluctuations, but good managers produce a good average market price and bad managers produce a bad average market price. (See Chap. 19).
13.8 Zweig on Chapter 8
Investing intelligently is about controlling the controllable.
You can’t control the market, but you can control:
. YOUR OWN BEHAVIOUR (most important of all)
. brokerage costs – by trading rarely, patiently and cheaply
. ownership costs – by not buying funds with high annual expenses
. your expectations – by being realistic about potential returns (see footnote, p. 219)
. your risk – by deciding how much of your total assets are in the stock market; by diversifying; and by re-balancing.
. your tax bills – there are ways of reducing Capital Gains Tax.
The only time it makes sense to sell at a loss is for tax purposes, at the end of the tax year, then you wait 30 days and re-invest in the same company in the new tax year. (Lyle’s note: this is the way they do it in the US, according to Zweig. This may not be worthwhile/permitted/feasible in the UK)
....................................................................................... and, finally,
investing is not a game or competitive sport, it’s not about beating others at their game, it’s about controlling yourself and your own game and preventing yourself from being your own worst enemy by buying high when the market says “buy” and by selling low just because the market says “sell”.
The whole point of investing is not to earn more money than average but to earn what you need. The best way to measure your success is not by checking if you’re beating the market but instead by whether you’ve put in place a financial plan and the behavioural discipline that are likely to make your goals achievable. What matters is not crossing the finishing line before everybody else, but just making sure that you DO cross it. (See footnote, p. 220).
Don’t keep checking your share prices every day. Would you check the value of your house every day if you were able to? If the price of the house changed, would you rush out and sell it? By not checking, does it stop the value from rising? Would you enjoy living in your house if its price was available every day?
Different ranges of fluctuations for different types of investment:
. very small fluctuations – short maturity (< 7 years) high-grade bonds; savings bonds
. larger fluctuations – longer-term bonds
. largest fluctuations – shares
13.1 Market fluctuations as a guide to investment decisions
The intelligent investor can profit from fluctuations by way of timing and by way of pricing.
Timing is psychologically important for the speculator because he is only thinking short-term, he is in a hurry to take his profit, he hates the idea that he might have to wait a year or more for his shares to move up.
The intelligent investor should forget about timing, forget about market forecasts, and concentrate on pricing:
“Basic pricing” means “not paying too much for shares“.
This essential minimum of attention is probably enough for the defensive investor.
“More ambitious pricing” means “buying below fair price and selling above fair price”.
The speculator is always in a hurry, but the investor can wait. Timing is of no advantage to the investor unless it coincides with pricing. If you keep a large amount of cash in hand, waiting for the “right time to buy”, when prices are “low enough”, then you lose dividend income.
The only advantage of waiting with a large amount of cash is if you can buy later at a low enough price to make up for loss in dividend income.
13.2 “Buy low, sell high” approach
Forget about trying to forecast price movements.
While “buy low, sell high” is clearly a sound idea, it’s hard to know when the market has bottomed-out (for buying) and when it has reached its peak (for selling). Hence the policy of changing the proportion of shares to bonds to re-balance the portfolio, if desired, in response to market fluctuations. (This policy is called “tactical asset allocation”, see also Chap. 4, pp. 89-91).
13.3 “Formula invesment” plans
Dollar-cost averaging is the only important one.
13.4 Market fluctuations of the investor’s portfolio
“The investor may as well resign himself in advance to the probability, rather than the mere possibility, that most of his holdings will advance 50% or more from their low point and decline 33% or more from their high point at various periods in the next five years”.
The main advantage of the policy of varying the proportion of stocks to bonds is that it gives the investor something to do and it gives him the satisfaction that his actions are opposite to the actions of the masses of investors who buy when prices rise. (See “rebalancing”, p. 104-105).
13.5 Business valuations versus market fluctuations
A shareholder has a two-fold status:
a. as part-owner of (and “silent partner” in) a private business, his results are entirely dependent on the profits of the enterprise and changes in its assets, he can calculate his share of the net worth from the latest balance sheet.
b. he is the holder of a share certificate which can be sold quickly. The selling price can be quite far removed from the balance-sheet value.
The development of the stock market has made the typical investor less free to consider himself as the part-owner of a business.
This is because he has to pay a “market premium” for the successful enterprises in which he is likely to concentrate his holdings, i.e. such enterprises sell at prices well above their book value.
(Zweig: book value, net asset value, balance sheet value and tangible asset value are synonyms for net worth.)
Book value is the total value of a company’s physical and financial assets minus all liabilities.
You can calculate “book value per share” (BVPS) from the balance sheet in a company’s annual and quarterly reports, using the following formula:
BVPS = (total shareholders’ equity – soft assets*) / (fully diluted no. of shares)
(*) soft assets = goodwill, trademarks and other intangibles
There is a built-in contradiction in the structure of stock-market prices: the better the company’s record and prospects, the less relationship there is between the price of shares and the book value of the company (Lyle’s note: and so the higher the premium), but the higher the premium, the more this “value” depends on the changing moods of the stock market.
Final paradox: the more successful the company, the greater the fluctuations are likely to be and hence the higher the quality of the company, the more speculative it is likely to be, e.g. IBM and Xerox have had striking losses at times, not because of any doubts about the companies themselves but because of a lack of confidence in the market about the valuation of the market premium.
The premium can be considered as a sort of extra fee which is paid for the advantages of marketability which are achieved by being listed on the stock market. The defensive investor might be better to confine himself to companies with premiums less than 33%,
... but a word of warning - this alone is not enough to indicate a sound investment, which has: a low premium, a satisfactory p/e, a strong financial position and good prospects that earnings will continue into the future.
13.6 “Mr Market”
Graham says that it can be useful to imagine that the market is a person called “Mr Market” who comes to you every day and makes suggestions about your portfolio (sell, buy, hold).
The true investor can choose to accept or refuse Mr Market’s suggestions, this is the investor’s basic advantage.
Mr Market’s suggestions are only important in the practical sense that they give an indication that levels might be attractive for buying or selling.
13.7 Summary
“The most realistic distinction between the investor and the speculator is in their attitude to stock market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in finding (and holding) suitable investments at suitable prices.”
Holding off until low prices appear before buying may sometimes involve a very long wait, and hence a loss of dividend income over the waiting period.
If you suddenly have money to invest, bargains can be found at any time if you know how to look for them.
The investor with a portfolio should expect price fluctuations, even large fluctuations.
He should never buy a share because it has gone up or sell one because it has gone down. More simply, never buy shares immediately after a substantial rise or sell after a substantial drop.
The management of companies can not be held accountable for overall market fluctuations, but good managers produce a good average market price and bad managers produce a bad average market price. (See Chap. 19).
13.8 Zweig on Chapter 8
Investing intelligently is about controlling the controllable.
You can’t control the market, but you can control:
. YOUR OWN BEHAVIOUR (most important of all)
. brokerage costs – by trading rarely, patiently and cheaply
. ownership costs – by not buying funds with high annual expenses
. your expectations – by being realistic about potential returns (see footnote, p. 219)
. your risk – by deciding how much of your total assets are in the stock market; by diversifying; and by re-balancing.
. your tax bills – there are ways of reducing Capital Gains Tax.
The only time it makes sense to sell at a loss is for tax purposes, at the end of the tax year, then you wait 30 days and re-invest in the same company in the new tax year. (Lyle’s note: this is the way they do it in the US, according to Zweig. This may not be worthwhile/permitted/feasible in the UK)
....................................................................................... and, finally,
investing is not a game or competitive sport, it’s not about beating others at their game, it’s about controlling yourself and your own game and preventing yourself from being your own worst enemy by buying high when the market says “buy” and by selling low just because the market says “sell”.
The whole point of investing is not to earn more money than average but to earn what you need. The best way to measure your success is not by checking if you’re beating the market but instead by whether you’ve put in place a financial plan and the behavioural discipline that are likely to make your goals achievable. What matters is not crossing the finishing line before everybody else, but just making sure that you DO cross it. (See footnote, p. 220).
Don’t keep checking your share prices every day. Would you check the value of your house every day if you were able to? If the price of the house changed, would you rush out and sell it? By not checking, does it stop the value from rising? Would you enjoy living in your house if its price was available every day?